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Exam 10: Making Capital Investment Decisions

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Question 41

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Corner Market is considering adding a new product line that is expected to increase annual sales by $418,000 and cash expenses by $337,000. The initial investment will require $390,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the six-year life of the project. Ignore bonus depreciation. The company has a marginal tax rate of 21 percent. What is the annual value of the depreciation tax shield?

A) $13,650
B) $13,160
C) $27,300
D) $163,800
E) $136,500

F) B) and C)
G) A) and E)

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Question 42

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The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following?

A) Yearly incremental costs
B) Sunk costs
C) Opportunity costs
D) Annuitized erosion cost
E) Equivalent annual cost

F) A) and E)
G) B) and D)

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Question 43

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Pre-Fab purchased some equipment two years ago for $287,600. These assets are classified as five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576, for Years 1 to 6, respectively. The company is currently replacing this equipment so the old equipment is being sold for $150,000. What is the aftertax salvage value from this sale if the tax rate is 21 percent and no bonus depreciation is claimed?

Which one of the following should not be included in the analysis of a new product?

Winn Corp. currently sells 9,820 motor homes per year at $45,500 each, and 3,680 luxury motor coaches per year at $89,700 each. The company wants to introduce a new portable camper to fill out its product line. It hopes to sell 4,000 of these campers per year at $14,750 each. An independent consultant has determined that if the new campers are introduced, sales of its existing motor homes will most likely increase by 250 units per year while the sales of its motor coaches will probably decline by 368 units per year. What is the amount that should be used as the annual sales figure when evaluating the portable camper project?

Ausel's is considering a five-year project that will require $738,000 for new fixed assets that will be depreciated straight-line to a zero book value over five years. No bonus depreciation will be taken. At the end of the project, the fixed assets can be sold for 18 percent of their original cost. The project is expected to generate annual sales of $679,000 with costs of $321,000. The tax rate is 22 percent and the required rate of return is 15.2 percent. What is the amount of the aftertax salvage value?

ALUM Inc. uses high-tech equipment to produce specialized products. Each one of its machines costs $1,243,000 to purchase plus an additional $78,000 a year to operate. The machines have a five-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 16.5 percent?

Changes in the net working capital requirements:

Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?

A project will require $543,000 for fixed assets, $118,000 for inventory, and $142,000 for accounts receivable. Short-term debt is expected to increase by $65,000. The project has a six-year life. The fixed assets will be depreciated straight-line to a zero book value over the life of the project. No bonus depreciation will be taken. The project is expected to generate annual sales of $905,000 with costs of $730,000. What is the project's cash flow at Time 0?

A proposed expansion project is expected to increase sales by $74,300 and increase cash expenses by $46,900. The project will require $52,800 of fixed assets that will be depreciated using straight-line depreciation to a zero book value over the five-year life of the project. The store has a marginal tax rate of 23 percent. What is the operating cash flow of the project using the tax shield approach? Ignore bonus depreciation.

Dan is comparing three machines to determine which one to purchase. The machines sell for differing prices, have differing operating costs and machine lives, and will be replaced when worn out. Which one of the following computational methods should Dan use as the basis for his decision?

Phone Home, Inc. is considering a new five-year expansion project that requires an initial fixed asset investment of $6.089 million. The fixed asset will be depreciated straight-line to zero over the project's life, after which time it will be worthless. No bonus depreciation will be taken. The project is estimated to generate $4,389,000 in annual sales, with costs of $1,731,200. The tax rate is 24 percent. What is the annual operating cash flow for this project?

Pro forma statements for a proposed project should generally do all of the following except:

A new molding machine is expected to produce operating cash flows of $109,000 a year for 4 years. At the beginning of the project, inventory will decrease by $8,700, accounts receivables will increase by $9,500, and accounts payable will decrease by $5,200. All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $319,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. No bonus depreciation will be taken. The equipment will be salvaged at the end of the project creating an aftertax cash inflow of $51,600. What is the net present value of this project given a required return of 14.2 percent?

You are considering the purchase of a new machine. Your analysis includes the evaluation of two machines that have differing initial and ongoing costs and differing lives. Whichever machine is purchased will be replaced at the end of its useful life. You should select the machine that has the:

Houston's is considering a project that will produce incremental annual sales of $361,000 and increase cash expenses by $198,000. If the project is implemented, taxes will increase from $31,000 to $47,000. The company is debt-free. What is the amount of the operating cash flow using the top-down approach?

Assume you are considering two mutually exclusive machines and need to select one for a cost-cutting project. Which one of these sets of characteristics best indicates the use of the equivalent annual cost method of analysis?

You just purchased $218,000 of equipment that is classified as five-year MACRS property. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for Years 1 to 6, respectively. What will be the book value of this equipment at the end of three years assuming no bonus depreciation is taken?

EDP is trying to decide between two different conveyor belt systems. System A costs $438,000, has a six-year life, and requires $83,000 in pretax annual operating costs. System B costs $369,000, has a five-year life, and requires $92,000 in pretax annual operating costs. Both systems are to be depreciated straight-line to zero over their lives and will have a zero salvage value. Whichever system is chosen, it will not be replaced when it wears out. The tax rate is 23 percent and the discount rate is 14.2 percent. Which system should the firm choose and why?